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Weekly Trader’s Outlook

Equities volatile on growing virus fears.

Follow me on Twitter @RandyAFrederick. I’ll tweet interesting observations about volatility, put/call ratios, technical signals, economics, option block trades and other unusual activity.

Weekly Market Review:

Earnings Summary

We’re now in the home stretch of Q4 earnings season. With 438 companies (87%) of the S&P 500 reporting, below are the aggregate results for Q4 relative to the final results from recent quarters.

Quarter EPS beats        Rev beats

Q4 ’19              75%                  66%     

Q3 ‘19               78%                  58%

Q2 ‘19               76%                  56%

Q1 ‘19               77%                  57%

Q4 ’18               73%                  60%     

Q3 ’18               82%                  61%     

Q2 ‘18               84%                  72%

Q1 ‘18               81%                  74%

Q4 ’17               78%                  76%     

Q3 ’17               78%                  68%     

Q2 ‘17               77%                  69%

Q1 ’17               78%                  63%

Q4 ’16               73%                  53%

Q3 ‘16               72%                  55%

Q2 ‘16               72%                  53%

Q1 ’16               72%                  52%

Average            75%                  58%

Looking at Q4 earnings from a growth standpoint, among the companies that have reported, EPS growth is +1.6% y/o/y and revenue growth is +3.6% y/o/y. This compares to -1.1% and +3.3% respectively in Q3. Below are some of the higher-profile companies that reported earnings this week.  

Earnings Recap

Symbol            Actual  Estimate

WMT                 1.38      1.44

AAP                 1.64      1.35

PCG                 0.68      0.66

A                      0.81      0.81

DISH                0.69      0.58

ELAN                0.23      0.23

CAR                 0.73      0.48

WMB                0.24      0.24

DPZ                 3.12      2.98

FSLR                2.21      2.79

DE                   1.63      1.25

Economics Recap

Better (or higher) than expected:

  • PPI for Jan: +0.5% vs. +0.1% est
  • Core PPI for Jan: +0.5% vs. +0.1% est
  • Housing Starts for Jan: 1567k vs. 1450k est
  • Building Permits for Jan: 1551k vs. 1470k est
  • Leading Economic Indicators for Jan: +0.8% vs. +0.5% est

On Target:

  • Existing Home Sales for Jan: 5.46M vs. 5.46M est

Worse (or lower) than expected:

  • NAHB Housing Market Index for Feb: 74 vs. 76 est
  • Initial (weekly) Jobless Claims: 210k vs. 208k est
  • Markit Manufacturing PMI for Feb: 50.8 vs. 51.5 est
  • Markit Services PMI for Feb: 49.4 vs. 53.4 est

This was a relatively light week for economic reports and this week I’d like to highlight the Producer Price Index. Both the headline and the core index came in sharply higher than expected. These increases translate to +2.1% and +1.7% respectively, on a year/over/year basis. Still, these levels are relatively tame, and very little, if any of the increases translated through to the Consumer Price Index, which was released last week. As you can see in the y/o/y Core PPI chart below, this is the first real uptick in 12 months, but it only brings it back to early-2017 levels.

PPI

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Also worth noting is the Markit Services PMI, which reflected not only a sharp decline, but also a dip into recession territory (<50) for the first time since these reports have been available. However, since they only go back to the beginning of 2016, I would caution about overreacting to them. The ISM Services PMI (which goes all the way back to 1996) will be reported on 3/4. If that one reflects a similar contraction, we can get concerned then.

Market Performance YTD

Here is the 2020 YTD (versus 2019 full-year) performance of the market broken down by the 11 market sectors (as of the close on 2/20/20):

                                                2020 YTD                      2019 Final

  1. Info Tech                      +10.7%                         +48.0%
  2. Utilities                         +8.5%                           +22.2%
  3. Real Estate                   +7.7%                           +24.9%
  4. Consumer Disc             +6.3%                           +26.2%
  5. Communications Svc  +5.6%                           +30.9%
  6. Industrials                     +2.9%                           +26.8%
  7. Cons Staples                +2.4%                           +24.0%
  8. Healthcare                     +1.3%                           +18.7%
  9. Financials                     +0.7%                           +29.2%
  10. Materials                       -1.4%                            +21.9%
  11. Energy                           -9.9%                            +7.6%

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Here is the 2020 YTD (versus 2019 full-year) performance of the major U.S. equity indices (as of the close on 2/20/20):

                                                            2020 YTD                      2019 Final

  • S&P 500 (SPX)                            +4.4%                           +28.9%
  • Nasdaq Composite (COMPX)    +8.7%                           +35.2%
  • Dow Industrials (DJI)                 +2.4%                           +22.3%
  • Russell 2000 (RUT)                    +1.7%                           +23.7%

Technicals

Volatility picked up this week as new uncertainties over the COVID-19 virus emerged, but that didn’t keep the SPX from logging another new high. With the most recent record high on Wednesday (2/19), the upside resistance has increased to 3,386. The first line of support for any new decline will probably occur at the 50-Day SMA (now 3,274). I also continue to watch 3,214 and below that, the -10% correction line of 3,047 and the old support line of 3,025.

SPX

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Bull Market Trends

With a new SPX high on Wednesday (2/19), below is an update of the table showing how this bull market compares to others in the post WW II era. At 3,999 days in duration, it is now 547 days longer than the internet bull market, but at just over +400%, it remains second highest with regard to the percentage increase. The SPX would only need to reach a level of about 3,500 to exceed the 417% gain of the strongest bull market in history. This would be a gain of about +8.5% in 2020, which is a scant +3.4% above current levels.

bull markets

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

Option Volumes:

As we near the February monthly option expiration, aggregate industry volume is averaging a robust 24.9M contracts per day. That is very close to the January level of 24.8M contracts per day and well above the February 2019 level of 18.6M contracts per day. According to my records, this is the highest month ever for option volumes; no doubt driven by the longest bull market in history and a significant decline in commission costs at many firms over the past few months.

Open Interest:

OI Change:

In reviewing Cboe open interest (OI) data (where greater than 90% of the index activity occurs), I observed the following changes over the past week:

In reviewing VIX data for the past week I observed the following:

  • VIX call OI was -26.6%              
  • VIX put OI was -46.9%              

These sharp decreases are due to the February monthly contract expiration on Wednesday (2/19) and are therefore N/A this week.  

In reviewing SPX data for the past week I observed the following:

  • SPX call OI was +2.3%
  • SPX put OI was +2.3%             

These changes reflect no bias toward the call or put side this week, so I see them as neutral for equities this week.

In reviewing Exchange Traded Products (ETP) data (which includes SPY & QQQ) for the past week, I observed the following:

  • ETP call OI was +0.4%            
  • ETP put OI was +0.5%              

These changes reflect an insignificant bias toward the put side this week, so I see them as neutral for equities this week.

Combining VIX, SPX & ETP data this week, overall I see the Index/ETP OI Change as neutral in the near-term.

In reviewing Cboe Equity Option data (where about 35% of all option activity occurs) for the past week I observed the following:

  • Equity call OI was +1.8%                      
  • Equity put OI was +1.7%                      

These changes reflect an insignificant bias toward the call side this week, so I see the Equity OI Change as neutral in the near-term.

OI Participation

Index OI Participation is currently +6.3% versus 2018 levels, so I see it as moderately bullish in the long-term.

Equity OI Participation is currently +12.1% versus 2018 levels, so I see it as bullish in the long-term.

Open Interest Put/Call Ratios (OIPCR):

The VIX OIPCR is down 12 ticks to 0.29 versus 0.41 last week. At this time, VIX options traders are holding (long or short) only 29 puts for every 100 calls. While this decrease is quite substantial, it is not uncommon given the February monthly contract expiration on Wednesday (2/19), so it has been greatly exaggerated. This also explains why it is inconsistent with the move in the VIX index, which was +1.88 (+13.7%) through Thursday (2/20) this week. At this level, this ratio is now (at least temporarily) well below the 200-day SMA (Simple Moving Average) of 0.38.

At the risk of overstating the impact of expiration, I think it’s safe to assume that at least a modest decline would have occurred anyway, and that means VIX options traders are probably not expecting the VIX to fall very much, any time soon. Therefore with the VIX modestly elevated, I see the VIX OIPCR as moderately bearish in the very near-term for the markets. Since this ratio had been mostly flat over the past 4 weeks, I see it as neutral in the long-term.

This week the SPX OIPCR is up 2 ticks to 2.34 versus 2.32 last week. At this level this ratio remains well above the 200-day SMA of 2.14. Under normal circumstances, this ratio will move in the same direction as the index, so the fact that it has ticked up modestly even as the SPX has fallen less than 7 points (-0.2%) through Thursday (2/20), is somewhat unusual. SPX option traders (who are almost entirely institutional) appear to be slightly less confident that the SPX will hold at current levels in the near term. At this level I see the SPX OIPCR as moderately bearish in the near-term for the market. Since it is now mostly unchanged over the past 3 weeks, I see it as still neutral in the long-term.

The normally stable Equity OIPCR is down 1 tick to 1.00 versus 1.01 last week. While equities were down modestly this week, equity option traders established new positions in both call and put options in nearly equal amounts again. Thus at this level I see the Equity OIPCR as neutral in the near-term for the market. And since it is still close to its 200-day SMA of 1.02, I see it as neutral in the long-term.

Cboe Volume Put/Call Ratios (VPCR):

The Cboe VIX VPCR has been mostly neutral this week. The 0.49 reading on Thursday (2/20) was neutral and the current reading of 0.89 as I’m writing this (mid-day Friday 2/21) is neutral. Therefore, I see it as neutral in the very near-term.

The Cboe SPX VPCR has been moderately bearish this week. The 1.82 reading on Thursday (2/20) was moderately bearish, and the current reading of 2.34 as I’m writing this (mid-day Friday 2/21) is bearish. Since intraday levels tend to decline as the day goes on, I see this ratio as moderately bearish in the very near-term. With a 5-day average of 1.83 versus 1.70 last week, it remains moderately bearish in the long-term.

The Cboe Equity VPCR has been quite bullish all week. The 0.51 reading on Thursday (2/20) was bullish but the current reading of 0.79 as I’m writing this (mid-day Friday 2/21) is moderately bearish. Since intraday levels tend to fall throughout the day, I see it as volatile in the very near-term. With a 5-day moving average of 0.51 versus 0.50 last week, it is moderately bullish in the long-term.

As I’ve commented on for the past few weeks, some of the pre-virus bullish extremes are beginning to re-emerge. At just 0.45 on Wednesday (2/19), the CBOE Equity Volume Put/Call ratio was the lowest (most bullish) since 1/15, though the 5-day SMA is still just a few ticks higher. So like last week, not quite an extreme as it was 4 weeks ago, but getting very close, and certainly a reason for caution.

Since volume based put/call ratios are very reactive and very short-term in nature, near-term usually means just a day or two, while long-term is more like a week.

ISE Retail Sentiment Index (ISEE):

The ISEE closed slightly above 100 in all 3 sessions this week. Since this gauge measures only retail opening activity and it is actually a call/put indicator, a level above 100 means that retail option traders on the ISE are trading fewer puts than calls. Since the intraday level at the time of this writing is 115, I see the ISEE as moderately bullish in the near-term. Since this ratio has closed above 100 in only 6 of the last 10 sessions, I see the ISEE as neutral in the long-term.

OCC Volume Put/Call Ratios (VPCR):

The OCC Index VPCR has been moderately bearish this week. As a result, I see it as moderately bearish in the near-term. It has also been bearish or moderately bearish in 19 of the last 22 sessions, so I see it as still moderately bearish in the long-term                                                                             

The OCC Equity VPCR by contrast, has been very bullish again this week. As a result, I see it as bullish in the near-term. Since this ratio has been bullish or moderately bullish in 12 of the last 13 sessions, I see it as moderately bullish in the long-term.

Even more extreme than the Cboe Equity VPCR, the OCC Equity VPCR is indicating an even higher level of optimism/complacency among equity option traders; closing at just 0.61 on Wednesday (2/19); the lowest close since 1/8. Additionally, the 5-day moving average is now back to 0.68; essentially where it was a few days before the virus pullback started on 1/24. This caution flag is also waving again.

Volatility:

As I mentioned in the OIPCR section above, the VIX index was +1.88 (+13.7%) through Thursday (2/20). The 20-day historical volatility is 149% this week versus 145% last week.

Cboe Volatility Index (VIX)

As I’m writing this (mid-day Friday 2/21), the VIX is +2.46 points (to 18.02); still above the long-term statistical mode of 12.42 (or “normal” volatility) but just below the long-term statistical mean of 19.13. At this level, the VIX seems to be reflecting increased uncertainty about the spread of the coronavirus (See Asia section below), despite the SPX hitting another high earlier in the week. At this level I see the VIX as bearish in the very near-term for the equity markets. While it has fallen more than 2 points from recent highs, it remains more than 4 points above recent lows, I see it as moderately bearish in the long-term too.

On a week-over-week basis, VIX call prices have fallen modestly and VIX put prices have risen modestly. At +47 versus +133 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) has decreased and at this level I see it as neutral in the very near-term. However, since the gap has flipped from positive to negative a couple of times over the past 5 weeks, it remains volatile in the long-term. Keep in mind, this is not only a contrarian indicator, it tends to be one of the earliest and shortest-term indicators I discuss in this report, so it can also change directions very quickly.

VIX Futures

At the moment, the difference between the sum of the 3rd and 4th month futures and the 1st and 2nd month futures is +1.10 versus +2.60 last week. This decrease is mostly due to the near-term contract changeover related to the February monthly contract expiration on Wednesday (2/19).                             

As of this writing (mid-day Friday 2/21), the nearest VIX futures contract (which expires on 2/26) was trading at 16.85; more than a point below the spot VIX level of just 18.02. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 16.53; about 1½ points below the spot price.

With an adjusted level that is well below the spot price, futures traders are indicating that they believe the VIX is likely to come down a little in the near-term. Therefore, I see VIX futures as moderately bullish in the near-term for the market. The RPAPs of the next two closest monthly futures contracts are 15.48 and 15.02 respectively. With the RPAPs of the further-dated contracts also well below the spot price, I see VIX futures as moderately bullish in the long-term for the SPX.

Since VIX futures are typically much less reactive to current market conditions than the VIX index, near-term for VIX futures usually means a few days, while long-term means a couple of weeks.

The VIX has settled down somewhat this week and as a result, the VIX Hedging Effectiveness is now Moderate in the near-term. At the moment, this means that options on the VIX (and possibly other volatility-related products) are showing very little sensitivity to market volatility, and may not be very effective as hedging tools in the very near-term. VIX Hedging Effectiveness is Good in the long-term.

VIX Hedging Effectiveness is a manner of measuring the magnitude of VIX moves relative to the magnitude of SPX moves in the opposite direction. When the VIX is highly reactive, VIX related products can serve as potentially effective hedging tools, when the VIX is not very reactive, traditional hedging techniques may be a better choice.

Global Review/Outlook:

North America

Newly emboldened after signing the phase-1 trade agreement with China, President Trump will head to India next week to negotiate trade terms with Prime Minister Narendra Modi. About a year ago, the US ended the low-tariff status previously granted to India, and India retaliated by imposing tariffs on US steel exports.

Like China, India has a large population and is quickly becoming a global manufacturing and technology powerhouse by inviting foreign investment. But also like China, it has done so while also limiting other countries’ access to its consumer segment. President Trump will likely advocate for reciprocal trade agreements that involve substantial US exports, so India’s policy of supporting domestic manufacturing, and requiring technology transfer, will undoubtedly be problematic. Some estimates indicate as much as 50% of India’s imports are impacted by these policies.

Asia

At the time of this writing, over 76,000 cases of the COVID-19 virus have now been confirmed, including over 2,200 deaths. The Hubei province in China, which is at the center of the outbreak, reported a sharp drop in new cases this week, leading some to question the reliability of the data being released, especially since the methodology keeps changing. Perhaps more concerning is recent news about outbreaks outside of China, including more than 50 cases in a 24-hour period in the city of Daegu South Korea and more than 90 new cases in Japan; a 3-fold increase from the prior week.

On a positive note, the number of infections in children is emerging as uncharacteristically low. Data being analyzed by a few medical schools in the US indicate that among the diagnosed cases, children currently make up less than 0.2%. While the researchers cautioned that the analysis is very preliminary, it does appear that even among those children who have been infected, the symptoms have been very mild; no more severe than a common cold.

While it remains debatable how fast the virus in spreading, there is no debate whether or not the equity markets have moved on. Since the initial pullback ended on 2/3, the SPX has risen +5.0% and the Shanghai Shenzhen 300 Index has risen +12.3%. Below is an update of the table comparing the COVID-19 outbreak to others in the past. While I don’t want to minimize that fact that all deaths from this virus are tragic, and the total number of cases is fairly high, the death rate remains relatively low. Historically viral outbreaks have not had a significant or lasting impact on equity markets. Now 4 weeks following this outbreak, the SPX is +1.3%; slightly better than average.

Virus

Data obtained from multiple third party sources; accuracy not guaranteed

Past performance is no guarantee of future results.

Europe

In the immediate post-Brexit environment, the business-as-usual agreement between the UK and the EU allows for full access only through the end of December. However, on Wednesday (2/19) EU leadership in Brussels stated quite clearly that following the end of the transition period, the UK will get no special consideration with regard to financial market access. Instead, it will be treated in the same manner as Japan and the United States.

EU access has generally been granted if leadership believes that the non-EU country’s financial rules are as robust as those of EU members, and that they adequately focus on investor protection and financial stability. This could be problematic beginning in 2021, as a large portion of equity and derivatives trades in Europe currently take place in London and there are concerns that other EU markets may not have sufficient capacity to handle current volumes. Concerns over the transition have led more than 300 banks, insurers and asset managers in the UK to establish a presence in EU countries in an effort to minimize customer disruptions.  

Economic reports for next week:

Mon 2/24

None

Tue 2/25

Case-Shiller Home Price Index – This index measures the change in the average prices of single-family, residential real estate across a broad section of 20 major cities in the US.

Conference Board Consumer Confidence – There are several other confidence measures, such as the University of Michigan Consumer Sentiment, and they don’t always agree. Gasoline prices and stock market performance tend to have the biggest impact on these measures.  

Wed 2/26

New Home Sales – This report measures sales activity of newly constructed homes and other single family dwellings, and is generally considered less important than building permits since it is more of a trailing report.

Thu 2/27

Durable Goods Orders – This is a key measure of consumer and industrial spending trends and often causes market swings if it misses estimates.

Initial Jobless Claims - For the week ending 2/15/20, claims were up 4k to 210k after being up 3k the prior week. The 4-week moving average now stands at 209k, down 3k from the prior week. With this decline, the 4-week moving average is just 7k above the 48-year low set on 4/13/19.

GDP – This is the second estimate (Preliminary) for Q4 and the consensus estimate is that GDP will be upgraded to +2.2%. You’ll recall that the first (Advance) report in Q4 was +2.1%. 

Pending Home Sales Index – This report measures actual contracts signed, whereas existing sales (reported last week) measures actual closings, so this one is slightly more forward looking. This one will usually only affect equity markets adversely if it comes in very low.

Fri 2/28

Personal Income & SpendingThese reports use data from the monthly employment report to gauge income from wages and salaries. Personal income is also sometimes used to forecast future consumer spending.

Personal Consumption Expenditures (Core PCE) – PCE includes durable goods and nondurable goods which are directly influenced by the retail sales reports and services. This is the Fed’s preferred inflation gauge.

University of Michigan Consumer Sentiment – This is the Final report for Feb. At 100.9, the mid-month report was up from 99.8 the prior month.

Interest Rates:

The release of the minutes from the January 29th Fed meeting on Wednesday (2/19), not surprisingly mentioned the COVID-19 virus outbreak as a potential risk to the domestic economy. However, there were few hints that additional policy accommodation was imminent. So while Fed officials continue to believe their current monetary policy is “appropriate” to handle this exogenous event, markets appear to see things a bit differently.   

As I’ve shown by the green arrow below, the market seems to be expecting one rate cut this year, but as you can see in the red box, there is still quite a bit of uncertainty about when it will happen. It is worth noting, that the probability of a cut in March or April has fallen over the past week, whereas it has risen for June, July and September; which implies that it is unlikely to happen until the second half of the year, if at all.

WIRP

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Outlook:

With earnings season coming to a close and little else to move markets, COVID-19 virus news is likely to continue to dominate the headlines next week. Traders should be watchful of higher volatility and outsized market moves in both directions.

Bottom Line:

Last week I stated, “…with a 3-day weekend coming up and all of the virus news that will likely come out during that time, it seems like the more likely outcome is Volatile again, especially in the first part of the week”. With fairly large intraday volatility swings on both Tuesday (2/18) Thursday (2/20) and Friday (2/21), all at least partially related to virus news, but a modest loss in the SPX as of the close on Thursday, that outlook seemed about right.

As you can see below, there were several changes in the indicators again this week, but unfortunately they were not all in the same direction. Additionally, the virus outbreak is not yet contained and now it seems to be spreading faster outside of China. With earnings season nearly over, no Fed meetings, and a light economic calendar, virus news is likely to continue to be the main driver of the market. Therefore the outlook for next week is Volatile again. Remember, volatility likely means outsized moves in either or both directions.   

Composite

Past performance is no guarantee of future results.

Key:

OI = Open Interest

OIPCR = Open Interest Put/Call Ratio

VPCR = Volume Put/Call Ratio

IV = Implied Volatility

+ means this indicator has changed in a bullish direction from the prior posting.

– means this indicator has changed in a bearish direction from the prior posting.

+/ – means this indicator has changed bi-directionally; i.e. last week was either Volatile, N/A or Breakout.

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